United States: Second Circuit Narrows Reach Of Federal Securities Laws As To Foreign Securities Transactions

On May 6, 2014, the U.S. Court of Appeals for the Second Circuit
issued a decision clarifying the applicability of the anti-fraud
provisions of the Securities Exchange Act of 1934 to transactions
in foreign securities. The court held in City of Pontiac
Policemen's and Firemen's Retirement System v. UBS AG
that the Exchange Act does not apply to purchasers of a foreign
issuer's shares on a foreign exchange, even if those shares
were also cross-listed on a United States exchange, and even if the
purchasers on the foreign exchange were U.S. residents who had
placed their buy orders in the United States.

The UBS case is the latest decision construing the
Supreme Court's landmark ruling in Morrison v. National
Australia Bank and continues the trend of narrowing the
Exchange Act's applicability to only domestic transactions.

Background of the Second Circuit's Decision

Until June 2010, most courts throughout the United States had
analyzed the Exchange Act's extraterritorial application under
the so-called "conduct/effects test." The conduct test
had traditionally considered whether the defendant's conduct in
the United States was so significant as to have been more than
merely preparatory to the alleged fraud and to have directly caused
non-U.S. investors' losses. The effects test had considered the
alleged fraud's effects on U.S. markets or investors.

In June 2010, the Supreme Court in Morrison rejected
the conduct/effects test and adopted a supposedly bright-line rule
that § 10(b) of the Exchange Act applies only to
"transactions in securities listed on domestic exchanges, and
domestic transactions in other securities."

The first prong of this transactional test –
"transactions in securities listed on domestic exchanges"
– has generally seemed the more comprehensible prong,
although it has raised questions about whether § 10(b)
applies to transactions in securities that are not listed on
domestic exchanges if those securities are backed by domestically
listed securities or if the securities are dually listed. The
second prong – "domestic transactions in other
securities" (i.e., securities not listed on domestic
exchanges) – has generated extensive litigation.

In 2012, in Absolute Activist Value Master Fund Ltd. v.
Ficeto,the Second Circuit construed the second prong of the
Morrison test, dealing with securities not listed or
registered on a domestic exchange. The Second Circuit held that,
"to sufficiently allege the existence of a 'domestic
transaction in other securities,' plaintiffs must allege facts
indicating that irrevocable liability was incurred or that title
was transferred within the United States." A plaintiff can
demonstrate that irrevocable liability was incurred in the United
States by pleading facts showing that "the purchaser incurred
irrevocable liability within the United States to take and pay for
a security, or that the seller incurred irrevocable liability
within the United States to deliver a security." A plaintiff
can also satisfy the Morrison test by showing that the
United States was "the location in which title is
transferred."

TheUBSDecision

The UBS case was filed by plaintiffs who had purchased
shares of UBS – a Swiss corporation – on one or more
non-U.S. exchanges. The plaintiffs nevertheless sued in the United
States under the Exchange Act.

Some of the named plaintiffs were non-U.S. investors, who argued
that, because UBS's shares were cross-listed on the New York
Stock Exchange, investors could invoke Morrison's
first prong – for U.S.-listed securities – even though
their own transactions had taken place on a non-U.S. exchange. The
Second Circuit rejected this so-called "listing theory,"
reasoning that Morrison "evinces a concern with the
location of the securities transaction and not the
location of an exchange where the security may be dually
listed" (emphasis in original).

Another plaintiff was a U.S. entity that had purchased UBS
shares on a foreign exchange by placing a buy order in the United
States; the buy order was later executed on a Swiss exchange. This
plaintiff invoked Morrison's second prong – for
domestic transactions in unlisted securities – and contended
that, under the Absolute Activist test, it had incurred
"irrevocable liability" in the United States by placing
its buy order in this country.

The Second Circuit addressed what it called "an issue of
first impression – whether the mere placement of a buy
order in the United States for the purchase of foreign
securities on a foreign exchange is sufficient to allege that a
purchaser incurred irrevocable liability in the United States, such
that the U.S. securities laws govern the purchase of those
securities" (emphasis added). The court concluded that the
placement of "a buy order in the United States that was then
executed on a foreign exchange, standing alone," does
not establish that the plaintiff "incurred irrevocable
liability in the United States" (emphasis added).

What's Next?

The UBS decision appears to have dealt a death blow to
the "listing theory," at least within the Second Circuit.
The fact that a foreign security might be dually listed in the U.S.
appears to be irrelevant if the plaintiff's own transaction
took place on a foreign exchange.

But the decision might not be quite as dispositive as to
Morrison's second prong. The Second Circuit has
clearly foreclosed an argument that the placement of a buy order in
the United States is enough – on its own – to
constitute a domestic transaction. But the court's use of the
words "mere placement of a buy order" and "standing
alone" could lead to further litigation about whether other
factors – in addition to the location of the buy order
– could collectively constitute a domestic transaction under
Morrison's second prong.

The Second Circuit recognized in a footnote that it had stated
in Absolute Activist that "facts concerning the
formation of the contracts, the placement of purchase
orders, the passing of title, or the exchange of money may be
relevant to determining whether irrevocable liability was incurred
in the United States." The court also noted that it had made
that statement "in the context of transactions [not] on a
foreign exchange." But the court did not suggest whether those
same factors would or would not apply to transactions on a
non-U.S. exchange. Some of the questions that Absolute
Activist left open might therefore remain unresolved –
except as to the "mere placement of a buy order," without
any additional factors that might allegedly cause the purchaser to
incur irrevocable liability in the United States.

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